Opinion of an Alberta Lawyer on the Sarbanes Oxley Act
(Section 307 and proposed Part 205)
By Gregory J. Leia, Wolff Leia, Barristers & Solicitors, Calgary, Alberta
On November 21, 2002, the US Securities and Exchange Commission ("SEC") issued a Proposed Rule entitled "Implementation of Standards of Professional Conduct for Attorneys" (Release NO. 33-8150, 344-46868; IC-25829). The SEC asked for comments by December 18, 2002. This article contains the comments of a lawyer in private practice in Alberta, Canada. The response has been precipitated not only by the SEC request but as a response to Canadian securities regulators who are considering enacting similar legislation to harmonize securities laws relating to lawyers with the new securities laws in the United States (Sarbanes Oxley Act 2002 ("SOX")). The writer does not believe the adoption of the proposed laws are necessary in Canada. The article suggests changes to Part 205 so that they would not be inconsistent with existing Alberta securities laws.
On the table are three separate but connected initiatives: statutory sanctions for breaches of the securities laws, civil liability related to a lawyers role in securities transactions and the professional governance of securities lawyers. One significant connection amongst them is that the existence of a statutory duty resulting in a breach of securities laws may result in a regulatory sanction which in turn may provide the justification for a professional sanction and a judgement for monetary damages in a civil action. The US Congress has provided the SEC with broad powers to regulate and sanction lawyers. These rules apply to Canadian lawyers with US clients who file with the SEC. Viewed in the extreme these new rules may override the privilege granted by state and provincial legislators which have permitted lawyers to self regulate themselves as it relates to securities law matters.
At issue are very fundamental concepts for securities lawyers. No doubt the issuer is the client. But who else does the lawyer owe a duty of care to? Shareholders? Prospective investors? The public at large? Do the duties change if the lawyer becomes aware of fraud being perpetrated by the client? Are the duties different if the lawyer is also a director or officer of the issuer? What other roles is the lawyer being asked to perform? Is a lawyer required to make a reasonable independent investigation of his clients affairs to detect and correct false or misleading information? To ensure statutory compliance of his client? And how do these new roles impact on traditional concepts such as solicitor and client privilege? How do these new rules impact provincial law society rules which mandate confidentiality?
Should lawyers have a duty of care to prospective investors and the public in general such that in breach of their duty they should be sanctioned by a securities commission with regulatory sanctions. Should securities commissions have the ability to regulate the definition of this standard and mete out the sanction for breach of this professional conduct? What is important? Disgorgement of profits? Recovery of losses by investors?
Should lawyers have a duty of care to the public in general such that in breach of their duty they should become liable to the public in general for money damages in civil litigation? At present in Canada there is no statutory right of action, except in very limited situations. This would change if the proposed legislation in Ontario (Bill 198 introduced October 30, 2002) is passed into law and other provincial legislative bodies adopt similar legislation. Plaintiffs in Canada at present can rely on common law concepts of negligence and negligent misrepresentation. These actions are rare and difficult to win because the investors must establish reliance. Are there public policy reasons for limiting this right of action? Are there public policy reasons for eliminating the necessity for proving reliance?
Should lawyers be watchdogs? Gatekeepers? Whistleblowers? Should a lawyer play two roles: first as an advocate and confident to a client and second as an enforcement officer for the securities commission? Should securities laws weaken or destroy the concept of confidentiality and solicitor and client privilege by adopting rules which require mandatory reporting of securities violations? Would such laws be in violation of the Canadian Charter of Rights and Freedoms post LaVallee, Rackel and Heintz v. Canada (Attorney General) 2002 SCC 61 (SCC)? A law firm (supported by provincial law societies in Canada) successfully challenged the "whistleblowing" provisions in the money laundering legislation. Is it the same? Should a Canadian lawyer be faced with the situation where compliance of US securities rules result in violation of provincial rules? Does this bode well for compliance? Or will lawyers devise new schemes to restrict the flow of vital information to the marketplace because of the fear of sanctions and liability? It is the submission of the writer that if the SEC does not alter its proposed rules to take into consideration these foreign law issues that it will not succeed in achieving its target. Is there some way to achieve the objectives of the proposed rules in a fashion which harmonize rules in Canada and the US? We believe so, and the article makes suggestions in that regard.
This article suggests that the SEC and provincial securities commissions are using the opportunity provided by the public support to improve corporate governance "Post Enron" to obtain jurisdiction to impose statutory duties on lawyers which they did not previously have. The underlying premise seems to be as follows: Statutory compliance should be the responsibility of the issuer. However, society cannot trust management to "turn itself in to the police". So let's make the lawyer responsible. The "deep pockets" theory was not sufficient to enforce behaviour so lets attack their professional license to practice law. The writer argues that this concept is misguided. Corporate governance should be and can be accomplished without changing the role of lawyers.
The SEC and the provincial securities commissions appear to want to impose a statutory duty on securities lawyers to prospective investors and to the public in general to conduct independent investigations into clients affairs and be responsible for securities violations of their clients which they know or ought to know of. At least for now, thanks to the Alberta Court of Appeal, the Alberta Securities Commission ("ASC") will require amendments to the Alberta Securities Act to do so. Henderson v. Alberta Securities Commission 2002 ABCA 264 ("Henderson") Unfortunately the concept of the duty of the securities lawyer to the prospective investor to the public in general and legal corresponding responsibility of the lawyer is finding its way into the common law of negligence and negligent misrepresentation in Canada. Moreover, the provincial securities commissions want to go further. They want to regulate the professional standards of lawyers practicing in the securities law area presumably based on the concept of how well they meet the standards of care due to prospective investors and the public in general. The provincial securities commissions cite the present and proposal laws in the United States as justification (in particular SEC Rule 102(e)(1)(ii) and Part 205 to Title 17). In this article the writer argues that the proposed statutory, common law and professional practice duties on lawyers is not warranted on a fundamental principles basis and should not be adopted in Canada. We will discuss the present law in Alberta. We will discuss the US experience and proposals. The writer will argue that the SEC has had the ability to govern professional conduct of lawyers but has declined to do so because of the same fundamental reasons. The writer will argue that with appropriate changes to proposed Part 205 and corresponding changes to provincial securities rules the objectives appropriate corporate governance can be achieved without creating new duties on lawyers and without having securities commissions regulate the professional standards of lawyers.
As a separate topic not addressed in this article is the practical manner in which the lawyer would be held accountable by securities commissions in Alberta (and Canada generally). A lawyer may be subject to fines of $1,000,000 and jail. These are criminal sanctions. Worse, in Canada the lawyer will be adjudicated by a securities commission which is both the judge and prosecutor. The lawyer will be judged by an administrative body which has different burdens of proof, different evidentiary standards and difference procedures than courts. In Canada, the lawyer is not entitled to discovery of securities commissions' files. In Canada, there is no protection under the Canadian Charter of Rights and Freedoms. In Canada, there is no ability to obtain prehearing subpoenas. In Canada, there are no protections as in the SEC Rules of Practice. If adopted the duty will be judged with 20/20 hindsight and will not be defensible by a practicing lawyer.
In its decision dated September 13, 2000 sanctioning Colin Henderson, www.albertasecurites/enforcement orders/colin henderson/September 13, 2000 and November 10, 2000) the ASC stated:
"At some point, however, violations of securities laws become so apparent that it becomes unreasonable for a lawyer to rely upon the client, and, at that point, a lawyer becomes responsible for violations that they know or ought to know of. Even while acting as agent for their client, a lawyer must not be wilfully blind to, or knowingly commit, violations of the Act"
On October 29, 2002, the Alberta Court of Appeal allowed the appeal of Colin Henderson of a decision of the ASC dated September 13, 2000 and November 10, 2000. The case is important to lawyers who practice in the securities law area. Liberally interpreted, the case stands for the proposition that the Alberta Securities Act does not impose any statutory duty of care (on a know or ought to know basis) on a lawyer to prospective investors and the public in general to ensure securities law compliance for a client issuer which if breached would subject a lawyer to regulatory sanctions.
The facts are as follows. National Gaming Corporation ("NGC") was incorporated in the state of Delaware. NGC was to be in the bingo lottery business. NGC was extra-provincially registered in Alberta. NGC had prepared a Disclosure Memorandum which was meant to permit exempt distributions of securities in compliance with the federal securities laws of the United States and the state securities laws of Colorado, District of Columbia and New York. NGC sold common shares to at least 67 shareholders in Alberta between January 1, 1997 and August 31, 1997 and raised over $300,000 US. NGC did not file or receive a receipt for a prospectus from the ASC with respect to the sale of the securities. NGC purported to rely on the registration exemptions contained in subsection 65(1)(v) of the Alberta Securities Act, RSA 1981 c. S-6.1- ("Alberta Securities Act") and the prospectus exemptions contained in subsection 107(1)(p) of the Alberta Securities Act [The Alberta Securities Act was consolidated in 2000 as the Alberta Securities Act RSA 2000 c. S-4. The section numbers have changed. We propose to use the section numbers in place at the time of the alleged breaches].
The ASC found that NGC could not rely on the exemptions because NGC had breached various pre-requisites to the statutory exemptions, in particular:
(a) the number of purchasers exceeded 50 shareholders;
(b) Certain shareholders did not receive an "offering memorandum" as required;
(c) the Disclosure Memorandum did not comply with the form prescribed and was deficient for the following reasons:
(1) the failure to disclose the restrictions on resale;
(2) the failure to include any financial statements of NGC;
(3) the unauthorized inclusion of future-oriented financial information;
(4) the failure to disclose material contracts entered into by NGC;
(5) failure to disclose the limitation periods for investors contractual rights of action; and
(6) the failure to include a certificate by senior officers and directors.
(d) when the deficiencies were brought to the attention of NGC an Amended Disclosure Document was prepared which was itself deficient because it did not contain financial statements or requisite certificates. The Amended Disclosure Document was not provided to the investors;
(e) NGC provided to certain purchasers a "WSR Report" which constitutes an "offering memorandum" under the Alberta Securities Act. It was never filed with the ASC by NGC, nor did it comply with the requirements of the Alberta Securities Act and the Rules with respect to content and format;
(f) NGC did not obtain suitable acknowledgements from the purchasers that they were sophisticated; and
(g) NGC paid promotional expenses in contravention of the Alberta Securities Act.
Colin Henderson was the Alberta lawyer for NGC. He was not an officer, director or shareholder of NGC. He was not asked to and did not prepare the Disclosure Memorandum, the Amended Disclosure Memorandum, the WSR Report or the Form 20's which were required to be filed within 6 months of the first sale. He did meet with approx. 10 investors to ostensibly have subscription agreements signed and to receive funds on behalf of NGC. Evidence was heard from 4 of the investors.
The ASC acknowledged that Colin Henderson had practiced law in Alberta for 48 years with an unblemished record. The ASC accepted that Colin Henderson acted in good faith and in the honest belief that NGC was a legitimate business. The ASC found that Colin Henderson was not responsible for the serious deficiencies in the offering documents he distributed to investors. The ASC found that Colin Henderson honestly believed what he was told by Richard Cholak (de facto director) of a possible listing on an exchange. In the course of Colin Henderson's discussions with the investors, Colin Henderson advised the investors that NGC would be listed or would seek to be listed on an exchange (most likely OTC-BB) without the permission of the Executive Director of the ASC contrary to the provisions of subsection 70(3)(b) of the Alberta Securities Act. The ASC found that to the extent that Colin Henderson: (a) met with prospective investors; (b) gave them the Disclosure Memorandum and the WSR Report; (c) accepted their money: and (d) had them sign subscription agreements, he was acting merely as agent for NGC in the normal course of acting as legal counsel and these were not "trading" in securities within the definition of subsection 1(x)(v) of the Alberta Securities Act.
The ASC found that with respect to:
(a) 3 of the investors, Colin Henderson failed to deliver a Disclosure Memorandum;
(b) at least 1 of the investors, Colin Henderson failed to have the investors sign an acknowledgment that they were sophisticated purchasers; and
(c) with respect to all investors, Colin Henderson failed to have the appropriate form of acknowledgement signed.
Mr Henderson testified that he thought all of the offering documents complied with the Alberta Securities Act. He further testified that he did not believe he was engaged to ensure compliance and did not take any steps to ensure statutory compliance. Mr. Henderson testified that he was aware that some investors were not "sophisticated" in the colloquial sense and that there was an obligation to deliver the offering memorandum and have a sophisticated purchaser acknowledgement signed. The ASC found that Colin Henderson could not rely on NGC to deliver the offering memorandum, have NGC prepare the appropriate form of sophisticated investor acknowledgement and have this acknowledgement signed by each investor.
The ASC found that Colin Henderson had a positive obligation to do so. The omission or failure to do so constituted "trading" within the definition of subsection 1(x)(v) of the Alberta Securities Act. Because there was no receipt for a prospectus and because the prospectus and registrations exemption pre requisites had not been met, NGC and Colin Henderson were in breach of section 54 and 81 of the Alberta Securities Act.
The ASC ordered pursuant to section 165 of the Alberta Securities Act that the exemptions contained in sections 65, 66, 66.1, 107, 115, 116, 132 and 133 did not apply to Colin Henderson for a period of 5 years.
Although not specifically so stating in their decision, in its broadest context the decision stood for the following propositions:
- a lawyer owes a statutory duty of care to investors and the public in general to ensure statutory compliance with respect to the preparation of offering documents (sophisticated purchaser acknowledgements) and ensuring that the issuer fully complied with securities laws in all aspect of the offering process (delivery of the offering memorandum and the execution of the sophisticated purchaser acknowledgment);
- the lawyer will be become liable for statutory breaches (violations) of the issuer which they know or ought to know of (a negligence standard requiring the lawyer to conduct due diligence review of document and compliance procedures of the issuer);
- the ASC could regulate the professional conduct of lawyers by prescribing the standard of care required;
- the ASC could sanction the lawyer under section 165 (public interest) section; and
- the ASC could sanction the lawyer under section 161 for trading (penalty sections) although they chose not to do so in this case. This would have meant the lawyer could be liable for penalties of $1,000,000 and jail time.
On appeal, the Alberta Court of Appeal (www.albertacourts.ab.ca/ca/judgement database) stated:
"Apart from the allegations of unauthorized representations which are not under appeal, we are not satisfied that Mr. Henderson's proven activities were proscribed by the Securities Act. As we note that there are inconsistent findings of Henderson's actual "trading". At worst, Henderson was a dupe of Cholak and those who were in step with him. Mr. Henderson's dealings with the stock were in good faith. This prosecution must fail. As far as we can see, Henderson committed no sanctionable offence. We note that the Securities Commission, if it is so determined, may revisit the question of what sanction if any, should be imposed for unauthorized representation" [for breach of subsection 70(3)(b]"
Although not referenced in its decisions the Alberta Court of Appeal implicitly confirmed that it was not appropriate to read in "an omission" as an "act in furtherance of a trade" within the definition of subsection 1(x)(v) of the Alberta Securities Act or that such subsection created a reasonable standard for lawyers or otherwise. Although not referenced in its decision, the Alberta Court of Appeal, implicitly confirmed the decision in Ainsley Financial Corp. v. Ontario Securities Commission (1994),121 D.L.R. (4th) 79 (Ontario Court of Appeal) which stands for the proposition that the ASC does not have the inherent jurisdiction to issue a code of conduct for lawyers. Nor can it do so by a decision which may be considered as a binding precedent. The securities commissions' discretion under the Alberta Securities Act is limited to individual cases and does not confer authority to regulate participants generally. Again, although not referenced in its decision, the Alberta Court of Appeal implicitly confirmed the decision in Committee for the Equal Treatment of Asbestos Minority Shareholders v. Ontario Securities Commission (2001), 199 D.L.R. (4th) 577 (SCC). In that case lacobacci J. stated that the powers of the securities commission in relation to sections like 127 of the Ontario Securities Act [165 of the Alberta Securities Act] are limited by the effect of the intervention in the public interest on capital market enforcement and the public confidence in the capital market. Section 165 of the Alberta Securities Act is meant to restrain future conduct. The role of the securities commission is to protect the public by removing from the capital markets those whose conduct is so abusive as to warrant apprehension of future conduct detrimental to the integrity of the capital markets. In contradiction it is up to the commissions/courts to punish past conduct under sections like section 161 of the Alberta Securities Act.
It is the writers submission that the securities commissions can not issue remedial sanctions against lawyers under section 165 of the Alberta Securities Act (Asbestos). Without expressly so stating, the Alberta Court of Appeal was stating that the order by the ASC against Henderson was remedial and therefore the ASC did not have the jurisdiction to do so. So what could the securities commissions do? It is the writers submission that the powers of the commissions under section 165 of the Alberta Securities Act is limited to issuing a reprimand but cannot effect or restrict the professional practice.
This right was recognized in Wilder v. Ontario (Securities Commission) 197 D.L.R.(4th) 193 (Ont. C.A.). In Wilder, the Ontario Securities Commission ("OSC") commenced a proceeding against Mr. Wilder under section 127 of the Ontario Securities Act [equivalent to section 165 of the Alberta Securities Act]. Wilder challenged the OSC jurisdiction to sanction lawyers for professional misconduct. The Ontario Court of Appeal dismissed the motion by Wilder and stated that there was nothing inconsistent between the Law Societies role in regulating the legal profession and the OSC's exercise of its jurisdiction. It stated:
"The OSC has an important public interest role, that of protecting investors and the proper functioning of Ontario's capital markets. Ensuring proper disclosure and maintaining the integrity of the processes are an important part of its role. Here it is alleged that Mr. Wilder intentionally misled Commission staff during the course of a prospectus review by writing the letter quoted earlier. Nothing in the Law Society Act indicates that a lawyer should be immune from proceedings by the OSC under section 127(1)(6) where others would not be immune, soley because he is acting in a professional capacity. In proceedings such as these, the Commission is not usurping the role of the Law Society, as its objective is not to discipline the lawyer for professional misconduct; rather, its concern is to remedy a breach of its own Act which violates the public interest in fair and efficient capital markets and to control its own processes."
"While the applicants and intervenor made reference to the chilling affect in the independence of counsel appearing before the SEC, it is important to recognize that the OSC is not claiming powers here like those possessed by the SEC. The OSC is not seeking to control access to practice before it as can the SEC under Rule 2(e); rather it purports to exercise its public interest jurisdiction to determine whether an individual should be reprimanded because of alleged misconduct. As a matter of statutory interpretation, section 127(1)(6) can apply to a lawyer in a professional capacity."
Let us be clear the provincial securities commission want to control the professional conduct of securities lawyers. Although not stated expressly in the Henderson decision this is what the ASC was trying to do.
The British Columbia Securities Commission ("BCSC") in their concept paper released on February 18, 2002 acknowledges that provincial securities commissions have no enforcement options for dealing with professionals whose behaviour negatively affects the integrity of capital markets. The BCSC has proposed to recommend to the British Columbia government that they amend their legislation to permit the commission to prohibit professionals' from engaging in practice involving the commission if the professionals conduct related to trading in securities was so egregious or grossly incompetent as to be contrary to the public interest. A commission would be able to order that a professional not appear before it or prepare documents that are filed with it similar to the powers of the SEC under Rule 102(e). The nature of the powers and the use of these powers by the SEC is discussed later in this article.
The BCSC argues that the powers to limit a professional's ability to practice is the only way to address the pre Enron behaviour which is apparently in the minds of the BCSC is rampant in British Columbia. The fallacy of the BCSC argument is that if such law was in place it would have prevented Enron type situations. Readers should remember that SEC Rule 2(e) (predecessor to Rule 102(e)) was in place at the time of Enron. There is no empirical evidence that there is a need or that the solution solves the problem if the problem exists. The Henderson case is proof positive why you don't want the securities commissions regulating the conduct of the legal profession. Was the conduct of Mr. Henderson so egregious? The Alberta Court of Appeal was not going to permit the commissions to take away Mr. Henderson's "gown" after 48 years of unblemished practice. Readers should read the response by the British Columbia Law Society in a letter dated April 2002 which can be found on the BCSC website (www.bcsc.bc.ca/bcproposals/new-concepts-feb2002) (comments from industry).
II. Money Damages in Canada
Statutory private actions against lawyers are limited. Most plaintiffs commence actions under negligence or negligent misrepresentation. The case of CC & L Dedicated Enterprise Fund (trustee of) v. Fishman (2001) 18 B.L.R. 240 (Ont. S.C.) ("CCL Case") contains a good discussion of how Canadian courts have been eager to adopt the concept of duties on securities law counsel to the prospective investors and the public in general, and in particular duties to conduct reasonable independent investigations to detect and correct false and misleading information of the issuer failing which the lawyer will be liable for negligence or negligent misrepresentation notwithstanding lack of reliance.
In the CCL Case, the Plaintiffs commenced an action under the Class Proceedings Act, 1992 S.O. 1992 c.6. The Plaintiffs claimed on their own behalf and on behalf of the members of the class of persons who purchased or acquired common shares of YBM Magnex International, Inc ("YBM") distributed pursuant to a prospectus dated November 17, 1997 (the "1997 Prospectus") and suffered a loss as a result thereof. The Plaintiffs sought leave to amend their Statement of Claim to add Cassels Brock & Blackwell ("Cassels") a Toronto law firm and Lawrence Wilder, a partner in the firm. This was an interlocutory motion to determine whether the pleadings disclosed a cause of action. This was not a trial decision.
The pleadings alleged that Wilder drafted the 1997 Prospectus and that it contained various misrepresentations. It was as proposed to be amended alleged that Cassels and Wilder filed a consent with the securities regulatory authorities to the effect that the firm provided legal services with respect to the 1997 Prospectus and that they had no reason to believe that the 1997 Prospectus contained misrepresentations. The Plaintiffs alleged that Wilder and Cassels misrepresented that they "had conducted such reasonable investigations as was necessary to provide reasonable grounds for a belief that [the 1997 Prospectus] contained no misrepresentations" and misrepresented that the information constituted full, true and plain disclosure. Cassels provided a legal opinion on tax matters. Cassels provided a consent in reference within the 1997 Prospectus to the firms opinion as to "Eligibility for Investment" with respect to the shares being issued and to the inclusion of a reference to the firms name on the face page and under the heading "Legal Matters". The consent stated "we confirm that we have read the prospectus and have no reason to believe that there are any misrepresentations in the information contained in the prospectus that is derived from our opinion referred to above or that is within our knowledge as a result of the services provided in connection with such opinion".
The claim against Cassels was twofold. First as a partnership on the basis that the firm was responsible for the wrongdoings of Wilder. Second on the basis of negligence and negligent misrepresentation. Cassels and Wilder defended the motion on the basis that the pleadings as proposed did not disclose a reasonable cause of action against them.
The Ontario court reviewed the case law with respect to negligent misrepresentation and stated that the Plaintiffs must establish five elements:
- a duty of care based on a "special relationship" between the representor and the representee;
- the representation is untrue, inaccurate or misleading;
- the representor was negligent in making the representation;
- the representee reasonably relied upon the misrepresentation; and
- the reliance must have resulted in damages suffered by the representee.
Cassels and Wilder argued that they had no duty to individual investors. If they were "negligent" only the issuer would have an action against them. The court held that by permitting the name of the law firm to be referred to in the 1997 Prospectus that potential investors might possibly believe that Cassels was implicitly representing, at the least, that the firm had no reasonable grounds to believe that the prospectus contained any material misrepresentations. It was arguable that investors would reasonably rely upon the implicit misrepresentation by Cassels. Assuming that Cassels in fact has reasonable grounds to believe that the prospectus might contain material misrepresentations then arguably the firms silence while lending its name to the offering itself constituted a misrepresentation. Silence can constitute a misrepresentation when the silent party knows or should reasonably know that someone is relying upon that silence to constitute a representation that "full, true and plain" disclosure of all material facts had been made. See Kerr v. Danier Leather Inc.,  0.J. No. 4000 (Ont. S.C.J.)
With respect to the claim of negligence, the Plaintiffs stated that Cassels and Wilder had a duty to the plaintiffs to ensure that the 1997 Prospectus constituted "full, true and plain disclosure of all material facts relating to the securities offered". Cummings J. stated that the principles articulated by Mr. Justice La Forest in Hercules Management Ltd. v. Ernst & Young,  2 S.C.R. 165 (SCC) applied in respect of both the pleadings of negligent misrepresentation and the pleadings of negligence. That decision involved a motion for summary judgement dismissing an action by investors and shareholders in part in tort for alleged negligent misrepresentation against a corporation's auditor in respect of annual statutory audit reports.
Cummings J. reviewed the two part test for determining whether a defendant owed a duty of care. First does a relationship of proximity exist between two persons, such that the alleged wrongdoer can reasonably foresee that carelessness on his/her part is likely to cause damage to the person who has suffered damage, thereby giving rise to a prima facie duty of care? Second, if so, are there any factors or considerations which ought to limit or negate the scope of the duty, or the class of persons to whom it is owed, or the damages to which a breach of the duty may give rise?
Cummings J. found that there was sufficient proximity to give rise to a prima facie duty of care. On the second part, Cummings J. quoted Mr. Justice La Forest (Hercules) who in turn quoted at Cardozo C.J. "articulation in Ultramares Corp v. Touche, 174 N.E. 441 (U.S. N.Y., 1931) at p. 444 of the fundamental policy consideration to be addressed in negligent misrepresentation actions as being whether a defendant might be exposed to "liability in an indeterminate amount for an indeterminate time to an indeterminate class".
Cummings J. distinguished the limitation on suing auditors for public policy reasons on the basis that a statutory audit report is not generally prepared for the purpose of guiding personal investment decisions. Whereas the specific purpose of the legal services provided by Cassels was to enable IBM to raise more than $100 million from the investing public through the 1997 Prospectus. The court held that something more had to be established to extend the duty from the client in order to care for the purely economic interest of another. It is not enough simply that the lawyer could foresee that his/her conduct might cause loss or damage to those interests.
Cummings J. referred to decisions by American courts to a duty owed by a securities counsel of complete and accurate disclosure to potential investors with respect to a public offering in Federal Deposit Insurance Corp v. O'Melveny & Meyers, 969 F.2nd 744 (U.S.C.A., 1992) ("O'Melveny") reversed on other grounds, Caselaw-720337-512 U.S. 79 (U.S.S.C., 1994) wherein the US Court of Appeal stated (at page 4) that there is a "general rule that a lawyer has to act competently to avoid public harm when he learns that his is a dishonest client". Cummings J. also cites Felts v. National Account Systems Assn. Inc., 469 F. Supp. 54 (U.S. Miss., 1978) ("Felts"), 67 at paragraph 15, page 67, wherein the United States District Court stated that a securities counsel has a duty to make a "reasonable, independent investigation to detect and correct false or misleading materials". Cummings J. stated "That is, there must be a due diligence investigation. A statement in the offering that is made either with actual knowledge or with reckless disregard of whether it is true or false, on the part of securities counsel, can give rise to liability. The lawyer for the issuer may be liable to the investors if the court concludes that the sale of shares would not have been accomplished without the use and exploitation of the lawyer's name". Cummings J. goes on to state. "The several safeguards seen in securities legislation are grounded in important public policies designed to protect the interest of the investing public and, thereby, to enhance the mobility and formation of capital in a free market for the ultimate economic and social well being of society. Effective implementation of these safeguards depends to a considerable degree upon legal counsel who serves in an advisory capacity to the issuers of securities"
Cummings J. was not willing to negate the prima facie duty of care on policy grounds. In his view, a factual, evidentiary record is necessary to resolve the issue as to the second test: are there policy considerations which ought to negate or limit the scope of any duty of Cassels and Wilder, to whom the duty of care is owed or the damages to which a breach of duty may give rise? Cummings J. determined it was not possible or appropriate to try to resolve the issue at the preliminary stage of a pleadings motion.
Now whether Cummings J. was simply referring to California statutory law (O'Melveny) or was defining the common law in Canada is unclear. One might argue that if the Alberta Court of Appeal had affirmed the ASC decision in Henderson that there was a duty of care to investors generally, it would have been easier for Cummings J. to find a common law duty. One way or the other the obiter comments of Cummings J. will be used by Plaintiffs counsel in the future in Canada. The danger with reference to O'Melveny and Felts is that these cases:
(a) were determined with specific reference to US Federal and US State statutory laws;
(b) were decided in 1978 and 1991 and predate the US Supreme Court decision in Central Bank of Denver v. First Interstate Bank of Denver, 114 S. Ct 1439 (U.S.S.C) ("Central Bank case"); and therefore
(c) may not reflect the present US securities law post Central Bank (other than in California).
The O'Melveny decision has been criticized by several authors including Robert J. Haft "Liability of Attorneys and Accountants for Securities Transactions" 2002-2003 Edition West Group. The basis for the criticism is as follows:
First in the O'Melveny decision, counsel for O'Melveny admitted there was a duty by a principal and its agent of complete and accurate disclosure to potential investors in a securities offering to others to catch its client in a fraud. It was pretty easy for the court to find a duty by a principal and its agent of complete and accurate disclosure to potential investors in a securities offering.
Second, the Ninth Circuit in O'Melveny cited Felts for the proposition that "An important duty of securities counsel is to make a reasonable independent investigation to detect and correct false and misleading materials". In Felts, the defendant Peters was counsel to, and a director and president of, the corporation prior to and during the time of the securities offering, he resigned as president after many (but not all) of the securities were sold. The court found that he was actively involved in, and permitted his name and status to be utilized in, the sale of securities. Far from being independent of the issuer, the court held that Peters to be a "control person" of the issuer. The Felts court mistakenly relied upon Escott v. Bar Chris Construction Corp. 283 F. Supp 643, 2A.L.R. Fed 86 (S.D.N.Y. 1968) for the proposition that securities counsel must make a "reasonable, independent investigation to detect and correct false or misleading materials". In Bar Chris the attorney was also an officer or director of the issuer. The attorney defendants in Bar Chris were held liable under section 11 of the 1933 Act because of their failure as expressly named officers or directors of the issuer to meet the express due diligence defense of that section applicable to the named officers and directors. The courts have uniformly held that securities counsel, as such, have no due diligence duties under Section 11 unless also an officer or director.
Third, the Felts case quotes Koehler v. Pulvers, 614 F. Supp 829 (S.D. Cal 1985) as authority for securities lawyers to conduct independent investigation of information supplied by the issuer. Koehler involved a defendant attorney who drafted the private placement memorandum and rendered an exemption opinion under federal and California law, which opinion he intended to be distributed to investors as part of the private placement memorandum. Most importantly, the attorney knew that the private placement memorandum was materially misleading. Thus the reference in Koehler (citing Felts, infra) to securities counsels' due diligence duty to investigate to discover falsity is pure dicta.
The dangerous component of the duty for lawyers is the "ought to know upon independent due diligence review" test. It will be judged with 20/20 hindsight and will be impossible to defend. The test creates an ex post facto duty to investigate all material facts. Taken to the extreme of course if the lawyers for Bre-X Minerals had independently retained a drilling rig to verify the drilling results in Busang they would have discovered the fraud. A lawyer should make further inquiries if the facts are incomplete, are suspect, or inconsistent, or either on their face of other known facts are open to question. A lawyer should not have the responsibility to audit the affairs of his client or to assume, without reasonable cause, that a client's statement of facts cannot be relied upon. Surprise, surprise clients lie to their lawyers.
What is most disturbing about Cummings J. comments, albeit obiter dicta, is that the O'Melveny/Felts decisions were decided by a California court based on specific US federal and state statutory rules. Cummings J. makes no mention of the fact that the duties arose out of US federal or state statutes, the Central Bank case or the subsequent circuit court decisions which have followed or distinguished the Central Bank case. Without attempting to exhaustingly review such decisions, it would have been helpful for Cummings J. to outline the basis for how he managed to import US federal and state statutory liability or duties into the Canadian common law without regard to important US decisions which followed O'Melveny and Felts. It is submitted the obiter dicta of Cummings J. (with respect to the duties of counsel in the absence of fraud) is an example of the creation of bad law to remedy a perceived evil. Ultimately this will require a US Supreme Court and Canadian Supreme Court of Canada decision to decide the point.
III. Civil and Statutory Liability to Investors For Money Damages in the US
We do not propose to attempt to detail the civil or statutory liability of lawyers for breaches of securities laws of their clients (including for inadequate disclosure or materially misleading disclosure). It is difficult to compare the CCL Case with US law because, as we understand it, whatever lingering liability there might have been under common law for negligent misrepresentation is essentially pre-empted by the Securities Litigation Uniform Standards Act of 1998, which essentially requires all class actions asserting liability for disclosure violation to proceed in the federal courts. The reason for highlighting certain sections is to demonstrate how certain US Courts of Appeal have effectively "created" the same duty on lawyers as in the CCL Case and to reinforce the difficulty in foreign counsel trying to reconcile with the "US Law" is. If a Canadian lawyer files a document with the SEC , is he subject to the law in the Third or Eleven Circuit?
A. Securities Act of 1933 ("1933 Act").
Section 11. Section 11 of the 1933 Act imposes liability upon various classes of persons for any material misrepresentation or omission in a registration statement (which includes a prospectus). The Act differentiates between "expert" and "non expert" defenses. An attorney preparing the registration statement is not considered an "expert" as to the overall disclosure therein, and except for his "expertised" opinion which he is named as having rendered, he incurs no section 11 liability to investors. If the attorney is also a director or officer of the issuer as in Bar Chris and Feit v. Leaseco Data Processing Equipment Corp. 332 F. Supp 544 (E.D.N.Y. 1971), the court may hold the attorney to a higher standard.
Section 12. A seller will be liable to his immediate purchaser under section 12(a)(2) if the offer or sale is by means of a "prospectus or oral communication, which includes untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading". According to a 1995 decision of the United States Supreme Court (Gustafson v. Alloyd Co., 115 S. Ct 1061) section 12(a)(2) is applicable to public offerings by an issuer or a controlling person. Section 12(a)(2) permits the purchaser to recover whether or not he relied upon the misstatement, although a purchaser may not recover if he knew of the untruth or omission.
American plaintiffs have sued lawyers under section 12(1) and (2). Generally unless there was some very specific circumstances which tie the law firm to the purchaser and his investment decision, the courts have dismissed these actions.
The Central Bank case held that no aiding and abetting liability existed under section 10(b) of the Securities and Exchange Act of 1934 ("1934 Act") because the text of that section did not prohibit aiding and abetting. The express reference approach forecloses any liability for aiding and abetting under section 11, 12(d)(1) or l2(a)(2).
Section 17(a) of the 1933 Act. Section 17(a) provides in part:
"It shall be unlawful for any person in the offer or sale of any securities...directly or indirectly (1) to employ any device, scheme or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statement made, in light of the circumstances under which the statements were made, not misleading, or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser."
In Aaron v. SEC 446 US 680 (1980) the United States Supreme Court held that scienter is an essential requirement under subsection (1) of section 17(a) but is not required under subsections (2) and (3). This interpretation of subsections (2) and (3) suggests the duty of ordinary care and diligence. For the most part, section 17(a) cases have focused on the issue whether to imply a private cause of action for damages. The weight of authority is against implication of a private cause of action. But courts are divided on the case.
B. Securities and Exchange Act of 1934 ("1934 Act")
Section 10(b) and 10b-5. Section 10(b) of the 1934 Act prohibits the use "in connection with the purchase or sale of...any security...any manipulative or deceptive device or contrivance" in contravention of SEC Rules. Rule I0b-5, promulgated under section 10(b), provides:
"Employment of Manipulative and Deceptive Devices. It shall be unlawful for any person, directly or indirectly, by use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange (1) to employ any device, scheme, or artifice to defraud, (2) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statement made, in light of the circumstances under which they were made, not misleading, or (3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security"
The Rule applies to all transactions involving a security whether or not such transactions are exempt from the registration requirements of the 1933 Act.
A private right of action under Rule l0b-5 was confirmed by the United States Supreme Court in Herman & McLean v. Huddleston, 459 US 375 (198). It requires scienter ie with intent to deceive, manipulate or defraud. Section 21D(b)(4) of the 1934 Act introduced in 1995 provides that in "any private action arising under this title, the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to have violated this title caused the loss for which the plaintiff seeks to recover damages". Plaintiffs have used failure to disclose as a method to circumvent the prerequisite of reliance. The proof of materiality coupled with a duty to disclose is said to establish causation in fact. Actual reliance is inferred from materiality.
In 1994, the United States Supreme Court in the Central Bank case held that a secondary actor (lawyer) could not be held to aider and abettor liability for money damages under section 10(b) and Rule I0b-5. The Court found that such liability "exacts costs that may disserve the goals of fair dealing and efficiency in the securities market". The Court did not deal with potential exposure for liability as a primary violator of section 10(b). The potential exposure of a lawyer for liability as a primary violator of section 10(b) and Rule l0b-5 varies depending on which Court of Appeal hears the case.
In Klein v. Boyd, Fed. Sec. L. Rep. (CCH) 90,136 (3d Cir 1998), the Third Circuit held a law firm was a primary violator because it "elect[ed] to speak" by its authoring or co-authoring of document(s) with alleged material misrepresentations and/or material omissions; while the firm did not have an obligation to blow the whistle on its client, it did have a duty to correct its "statements". In other words a law firm should be held accountable for fraud when it helps to "create" a misrepresentation. Without so stating, the court seems to be stating that there is a duty of securities counsel to the prospective investor and the public in general to ensure securities law compliance for a client issuer which if breached would subject the attorney to civil liability.
Contrast that approach with that of the case of Ziemba v. Cascade International Inc., 256 F3d 1194 (11th Cir 2001), where the Eleventh Circuit dismissed a securities fraud action against a law firm. For the firm to have been liable as a primary violator of section 10(b) of the 1934 Act, the court ruled that the plaintiffs investors failed to make the proper alleged misrepresentations or omissions by the firm upon which they relied. And to the extent that the investors sought to hold the firm accountable for drafting, creating, reviewing or editing allegedly fraudulent letters or press releases put out by its client, the Eleventh Circuit held such liability was barred by the United States Supreme Court in Central Bank. The law firm did not have the duty to disclose and these were not liable for material omissions made in statements by their clients.
The SEC's authority to bring aiding and abetting actions was restored by statute in 1995 (Private Securities Litigation Reform Act of 1995 Pub. L. No 104-67; section 104, 109 stat. 737 - adding section 20(t) to the 1934 Act.) Section 20(t) provides that any person that "knowingly provides substantial assistance to another person" shall be deemed in violation to the same extent as the person to whom "such assistance" is provided. This would suggest actual knowledge - scienter is required as opposed to recklessness or even constructive knowledge - ought to know. Substantial assistance means that the activities of the alleged aider and abettor must have been a substantial and proximate factor of the primary violation and loss.
Section 18. Section 18 has an express private cause of action for materially false or misleading statements in documents required to be filed. Section 18 provides this action to a plaintiff who can prove he relied upon the materially defective statement and that the market price at which he purchased and sold the security was affected by the statement.
IV. Sarbanes Oxley Act 2002 ("SOX")
Introduced in July 30, 2002, Section 602 of SOX formalizes into legislation the ability to sanction lawyers. It does so by adding after section 48 of the 1934 Act, the following:
"Section 4C Appearance and Practice before the Commission,
(a) Authority to Censure - The commission may censure any person, or deny, temporarily or permanently, to any person the privilege of appearing or practicing before the Commission in any way, if that person is found by the Commission, after notice and opportunity for hearing in the matter-
(1) not to possess the requisite qualifications to represent others;
(2) to be lacking in character or integrity, or to have engaged in unethical or improper professional conduct, or
(3) to have violated, or wilfully aided and abetted the violation of, any provision of the Securities Laws or the rules and regulations issued thereunder.
(b) Definition - With respect to any registered public accounting firm or associated person, for the purposes of this section, the term "improper professional conduct" means-
(1) intentional or knowing conduct, including reckless conduct that results in violation of appropriate professional standards; and
(2) negligent conduct in the form of-
(A) a single instance of highly unreasonable conduct that results in a violation of applicable professional standards in circumstances in which the registered public accounting firm or associated person knows or should know that heightened scrutiny is warranted; or
(B) repealed instances of unreasonable conduct, each resulting in a violation of professional standards, that indicate a lack of competence to practice before the Commission.
Section 307 of SOX requires the SEC within 180 days of its enactment to promulgate rules in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the SEC in any way in the representation of issuers including a rule:
- requiring an attorney to report evidence of material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof; to the chief legal counsel or the chief executive officer of the company (or the equivalent thereof); and
- if the counsel or officer does not appropriately respond to the evidence (adopting, as necessary, appropriate remedial measures or sanction with respect to the violation), requiring the attorney to report the evidence to the audit committee of the board of directors of the issuer or to another committee of the board of directors comprised soley of directors not employed directly or indirectly by the issuer, or to the board of directors.
The Sarbanes Oxley Act does not create any new duties on an attorney (on a know or ought to know basis) to a prospective investor or the public in general to ensure statutory compliance for a client issuer which if breached would subject a lawyer to regulatory sanctions or civil liability.
V. SEC Promulgations - November 21, 2002
On November 21, 2002, the SEC announced proposed changes to SOX. New Part 205 to 17 CFR includes: (i) "up the ladder" reporting (section 307), and (ii) other related provisions the SEC believes are important to an effective reporting regime. The proposed rule would adopt an expansive view of who is an attorney subject to the rule, covering all attorneys who are admitted, licensed or otherwise qualified to practice law whether in-house by an issuer or retained to perform legal work on behalf of an issuer. In addition, the proposed rule would cover attorneys licensed or otherwise qualified to practice in foreign jurisdictions who appear and practice before the SEC.
Section 205.3 states that an attorney represents the issuer as an entity and the attorney is obliged to act in the best interests of the issuer and its shareholders. Subsection 205.3(b) would prescribe the duty to report evidence of a material violation. The obligation would be triggered when an attorney knew or reasonably believes that a material violation has occurred, is occurring or is about to occur, limiting the circumstances in which the reporting duty prescribed by the rule will arise to those where it is appropriate to protect investors. Section 205.3(d) would deal with the obligations of an attorney who has not received an appropriate response from the issuer and in certain circumstances, requires or permits a "noisy withdrawal". This would require an attorney to withdraw from representation, notify the SEC of their withdrawal and to disaffirm any submission to the SEC that they have participated in preparing which the attorney believes has been tainted by a material violation (and permits the attorney to disaffirm under other circumstances) all in a manner which would not violate solicitor and client privilege. Section 205.3(c) provides a "get out of jail free" card if he reports the material violation to a qualified legal compliance committee ("QLCC") which would then be responsible for taking the appropriate remedies, failing which each member of the QLCC would be responsible.
In addition, an attorney formerly employed or retained by an issuer who reasonably believes that he or she has been discharged because he or she fulfilled the reporting obligation imposed by the rule may, but is not required to, notify the Commission of his or her beliefs that he or she has been discharged for reporting evidence of a material violation and also disaffirm in writing any submission preparing which is tainted by the violation. A notification to the SEC under this section does not violate the attorney-client privilege. Paragraph 205.3(c) sets forth circumstances when an attorney may disclose confidential information.
Subsection 205.6 would describe the manner in which violations of the rule would be prosecuted by the SEC. Pursuant to Rule 102(e) (formerly Rule 3(b)) of the Act any violations of any rule issued by the SEC under the Act constitutes a violation of the 1934 Act. Accordingly, violation of the proposed rule would subject the violator to all remedies and sanctions available under the 1934 Act, including injunctions, cease and desist orders, officer and director bars for attorneys who are officers and directors.
Rule 102(e) (formerly Rule 2(e)) sets out the enforcement mechanism. The SEC has reformulated what constitutes "improper professional conduct" under Rule 102(e) to include negligent conduct. Rule 102(e)(1) states that "The Commission may censure a person or deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice and opportunity for hearing in the matter:
(i) not to possess the requisite qualifications to represent others; or
(ii) to be lacking in character or integrity or to have engaged in unethical or improper unprofessional conduct; or
(iii) to have wilfully violated, or wilfully aided and abetted the violation of any provision of the Federal securities laws or the rules and regulations thereunder.
The SEC has stated "We believe that Rule 2(e)(1)(ii) does not mandate a particular mental state and that negligent actions by a professional may, under certain circumstances, constitute improper professional conduct. Unlike Rule 2(e)(1)(iii), Rule 2(e)(1)(ii) does not require that conduct be "wilful". Nor do we believe that...the overall structure of the securities laws mandate that scienter is an element of Rule 2(e)(1)(ii)". (David J. Checkosky Norman A. Aldrich Exch. Act Release No. 31094, 52 S.E.C. Docket 1122 (August 26, 1992) (commissioner Roberts dissenting) in part), remanded on appeal, 23 F. 3d 452 (D.C. Cir 1994), aft'd, 63 S.E.C. Docket 1691 (January 21, 1997) (Exch. Act Release No. 38183) (2-1 decision). Paragraph 205.6(b) incorporates the same state of mind requirements that were adopted for accountants by the SEC in the 1998 amendments to Rule 102(e). Specifically an attorney is subject to discipline for (1) intentional, including reckless violations of the Part; and (2) negligent conduct in the form a single instance of highly unreasonable conduct that results in a violation, or repealed instances of unreasonable conduct resulting in a violation of the Part. The proposed rule also seems to import by reference into the statute the rules of professional conduct by self-regulatory organizations such as the American Bar Association and individual state regulatory bodies.
Rule 102(e)(2) states that: any attorney who has been suspended or disbarred by a court of the United States or of any State...or any person who has been convicted of a felony or a misdemeanour involving moral turpitude shall be forthwith suspended from appearing or practicing before the Commission.
Rule 102(e)(3)(i) permits the Commission, with due regard to the public interest and without preliminary hearing, may by order, temporarily suspend from appearing or practicing before it any attorney who has been by name:
(A) permanently enjoined by any court of competent jurisdiction, by reason of his/her misconduct in an action brought by the Commission, from violating or aiding and abetting the violation of any provision of the Federal securities laws or the rules and the regulations thereunder; and
(B) found by any court of competent jurisdiction in any action brought by the Commission to which he or she is a party or found by the Commission in any administrative proceeding to which he or she is a party to have violated (unless the violation was not found to have been wilful) or aided and abetted the violation of any provision of the Federal securities laws or of the rules and regulations thereunder.
Rule 102(f) states that "for the purposes of these Rules of Practice, practicing before the Commission shall include, but not limited to:
- transacting any business with the Commission; and
- the preparation of any statements, opinion, or other paper by any attorney, accountant, engineer, or other professional or expert, filed with the Commission, in any registration statement, notification, application, report or other document with the consent of such attorney, accountant, engineer or other professional or expert.
The proposed SEC Rules does create new duties on an attorney (on a know or ought to know basis) to a prospective investor or the public in general to ensure statutory compliance for a client issuer which if breached would subject a lawyer to regulatory sanctions or civil liability.
VI. SEC Historical Approach to Rule 2(e)(1)(ii)(now Rule 102(e)(1)(ii))
Regulating the Professional Conduct of Lawyers
Starting in the late 1960's, the SEC began to bring claims against lawyers who, in the agencies view, participated or asserted in their clients securities law violations. The SEC could bring civil enforcement actions before an Article III federal district court judge or it could commence administrative proceedings before an Article I administrative law judge (ACJ). The private bar challenged the actions on the basis that the SEC and the ACJ's did not have the statutory mandate to establish standards for the practice of law (same approach as Henderson) nor any special expertise in determining or applying such standards. Secondly, the threat of disciplinary action poses a form of intimidation which may mean that a lawyer's client is deprived of representation. The SEC recognized that administrative enforcement proceedings which endanger a lawyers ability to represent their clients adequately present a potential danger that is different in kind from that posed by enforcement proceedings against other types of professionals.
In William R. Carter and Charles J. Johnson Sec. Exch. Rel. No. 17597 [1980-81 Transfer Binder] Fed. Sec. L. Rep (CCH) 82,847 (February 28, 1981) involved ongoing disclosure advice by counsel with respect to periodic reports filed by the client under the 1934 Act. The client consistently rejected the proffered advice. The proceedings under Rule 2(e) was ultimately dismissed. The Commission had this to say:
"If a securities lawyer is to bring his best judgement to bear on a disclosure problem, he must have the freedom to make innocent - or even, in certain cases, careless - mistakes without fear of legal liability or loss of the ability to practice before the Commission. Concern about his own liability may alter the balance of his judgement in one direction as surely as an unseemly obeisance to the wishes of his client can do so in the other. While one imbalance results in disclosure rather than concealment, neither is, in the end, truly in the public interest. Lawyers who are seen by their clients as being motivated by fears of their personal liability will not be consulted on difficult issues."
Since Carter and Johnson, the Commission has followed an informal practice of only bringing Rule 2(e) proceedings against attorneys already enjoined or convicted of securities laws violations. Rule 2(e) proceedings Carter and Johnson have not involved charges of improper professional conduct under Rule 2(e)(1)(ii). All post 1981 Rule 2(e) cases against attorneys have been premised on injunctions against future securities violations. Then SEC General Counsel announced this policy in 1982. In 1988, the SEC ratified it: "with respect to attorneys, the Commission generally has not sought to develop or apply independent standards of professional conduct. The great majority of Rule 2(e) proceedings against attorneys involve allegations of violations of the law (not of professional standards); thus the Commission, as a matter of policy, generally refrains from using its administrative forum to conduct de novo determinations of the professional obligations of attorneys" (Ex. Act Release 25, 893, 53 Fed Reg. 26, 427, 26431 (1988). It is the submission of the writer that the objectives of corporate governance can be maintained by the SEC continuing the same practice and there is no necessity to alter its practice.
The SEC's authority was also challenged on the basis that it was unfair determination. Post 1993, the SEC revised its SEC Rules of Practice to include a codification of the presumption in favour of discovery from the Decision of Enforcement files, expansion of the respondents ability to obtain prehearing subpoenas, the creation of protective orders. See also the Article by Simone M. Lorne and W. Hardy Callcott, 50 Bus. Law 1293 (1995). See also cease and desist powers. See R. Witmer, SEC May Consider Cease and Desist to Sanction Attorneys for Misconduct, 33 BNA Sec Reg & 2 Rep 358 (March 12, 2001).
VII. Problems with Proposed Part 205
Again it is the writers submission that corporate governance is the issuers responsibility and not the lawyers. The lawyer should not have to make the "judgement call" whether or not the issuer is in breach of the rules. It should be up to the issuer to: (a) remedy the problem; (b) withdraw the "alleged" violative document; (c) disclose the problem to shareholders and/or SEC; (d) obtain another opinion as the whether there has been a violation; or (e) do nothing ("take its chances"). If the attorney does not feel he can continue to represent the client then he should be entitled to a "quiet withdrawal". The attorney should not be required to make a "noisy withdrawal" nor should he be required to notify the SEC or to disaffirm any document which he believes may be tainted. Although simplistic in nature the suggestion is consistent with the concept that the issuer has the responsibility and not the lawyer.
What would be the consequences of a "noisy withdrawal"? Before a lawyer "pulls the trigger" effectively the lawyer will have to conduct independent investigations into the affairs of his client in order to make his "judgement call". The risk the lawyer faces is that he could be "wrong" in his legal assessment based on inadequate information. The harm caused by a "public disavowment" would be significant. Not only will the lawyer be sued by his own client but by investors who lost money based on his error of law based on his failure to independently verify all the facts.
If he continues to act as counsel in the face of a fraud he will likely be liable under 10b-5 as a "primary violator". If he "quietly withdraws" he should not be liable under 10b-5 as a primary violator. In this manner, the attorney will not violate solicitor client privilege or other statutory or law society rules relating to confidential information.
To a Canadian lawyer, it is little comfort that he will not be held by the SEC to have breached solicitor client privilege or confidentiality rules in the US. He will still be subject to provincial rules and may lose his license. Faced with the alternative between losing his license in Canada and an unenforceable sanction in the US, the choice becomes clear.
Moreover, there should be a "Safe Harbour" provision for foreign lawyers who rely on US counsel. There should be a narrowing of the responsibility to a direct and substantial involvement in the preparation of documentation which ultimately gets filed with the SEC.
There are a number of tough issues. Does the counsel who has resigned have an obligation to notify new counsel of the reason for resigning? In Canada we have this obligation for auditors (National Policy 31). We think this is satisfactory as long as it does not involve a public disavowment or an SEC notification.
The other tough issue is where a lawyer has rendered an opinion which is included in an offering document which he believes may be tainted. Technically, the lawyer cannot unilaterally withdraw the document or correct the document. US regulators may wish to examine the approach taken by Bill 198 in Ontario.
If the SEC adopted these provisions it is likely to obtain cooperative assistance from law societies around the world to assist in the enforcement of the rules.
VIII. American Bar Association
The ABA on March 28, 2002 created a Task Force on Corporate Responsibility. The mandate was to "examine the framework of laws and regulations and ethical principles governing the role of lawyers and others". The Task Force submitted a Preliminary Report on July 16, 2002. The Task Force then scheduled a number of hearings. Of particular interest are specific recommendations to amend a number of Rules included as part of the Model Rules of Professional Conduct.
The Task Force intends to amend Model Rules 1.13, 1.2(d),1.6 and 4.1. The Recommendations Relating to Lawyers Responsibility and Conduct are summarized as follows:
- Amend Rule 1.13 to require the lawyer to pursue remedial measures for misconduct whether the problem is related to the representation or learned though the representation and to communicate with higher corporate authority where other efforts fail to prevent or rectify the problem, to make clear that the disclosure of confidential information to higher authority within the corporation does not violate Rule 1.6, and to revise language that discourages lawyers from communicating with corporate authorities.
- Extend permissible disclosure under Rule 1.6 to reach conduct that has resulted or is reasonably certain to result in substantial injury to the financial interests or property of another , and require disclosure under Rule 1.6 to prevent felonies or other serious crimes, including violations of federal securities laws, where such misconduct is known to lawyer.
- Expand Rules 1.2(d), 1.13 and 4.1 to reach beyond actual knowledge to circumstances in which the lawyer reasonable should know of the crime or fraud.
- Improve the linkage among the Model Rules relating to the obligations of a lawyer faced with illegal conduct to breach of a fiduciary duty in representing a corporate client.
These rules have not been adopted by the ABA. However, they mark a stark reversal by the ABA in their historical position relative to duties to prospective investors and the public in general. The amendments to Model Rule 1.2(d), 1.13 and 4.1 (and by implication 1.6) reflect a "duty" to prospective investors and the public in general on a "know or ought to know" basis. This would ultimately be reflected in a duty to conduct an independent due diligence review of the issuer in order to ascertain whether or not there is any fraud along with a concurrent duty to whistleblow. The approval of the existence of such duties by a body such as the ABA (or if adopted by the Canadian Bar Association) would also make it easier to establish the common law responsibility of lawyers and for the SEC to commence to use the regulatory authority under Rule 102(e)(1)(ii) which it had previously abstained from using. Again we believe this is the wrong approach and should not be adopted in Canada.
Lawyers practicing in the area of securities laws want certainty. They want to know and need to know whether they have a duty to prospective investors and the public in general. They need to know whether they must conduct an independent due diligence of all facts relating to their clients' affairs before they take on any engagement no matter how restricted. They need to know whether they must ensure whether every document and every process fully complies with securities laws. They need to know the time and cost required to effect an engagement and the inherent risk of being sued and charge accordingly.
Lawyers should not have a duty to a prospective investor or the public in general. The duty is inconsistent with the role of a lawyer as an advocate and confidential advisor. They need to be able to rely on their clients to provide accurate information. They should not be responsible for statutory compliance of their clients. Lawyers should not be held liable for regulatory sanctions, civil liability or professional sanctions whether provided by statute or by common law for matters relating to their clients for which they "ought to know". To do so will exact costs that may disserve the goals of fair dealing and efficiency in the capital markets by creating liability in an indeterminate amount for an indeterminate time to an indeterminate class. Lawyers should not become the guarantors of investor purchases. If the legislative bodies feel it is necessary to effect up the ladder reporting requirement by lawyers then should do so without imposing any duties on the lawyer to prospective investors or the public in general (public notice and disavowment - absent fraud). If there is fraud, then the counsel has the duty to inform management and if uncorrected then to resign. If counsel does not resign they run the risk of becoming a primary violator and liable to action. We suggest that this should be the law in the United States and in Alberta.
Leave the issue of professional regulation to the respective law societies. If the law society disbars a lawyer then the lawyer cannot file documents or appear before a provincial securities commission in his/her professional capacity. There is no need for the securities commissions in Canada to be given the authority similar to that set out in section 4C(a)(2) of the Securities and Exchange Act of 1934, Proposed Part 205 or as found in Rule 102(e)(1)(ii) of the SEC Rules. To date the SEC has had the authority and has chosen not to exercise the authority relating to the regulation of professional standards for lawyers. There is no reason for it to do so in the future. And there is no compelling reason for introducing such law in Canada.